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Roll-up under review

In reviewing the issues that will be discussed in connection with the newly-published consultation document on offshore funds, I started to look last week at some of the possibilities for a new system of taxation for offshore funds – one of a few developments on the horizon that could be relevant for those IFAs who advise on offshore investments or whose clientele include non-UK-resident and non-UK-domiciled clients.

One possibility, albeit the least likely, is that there could be no change in the tax treatment of roll-up funds. But this week I would like to look at possible reform. The Government&#39s key focus would be to:

•Reduce compliance costs for fund managers and increase their competitiveness.

•Reduce taxpayer uncertainty about the tax treatment of investment gains. This is especially important with regard to self-assessment and the need to input gains/income. With retrospective quali-fying status given to funds, it may well not be possible for taxpayers to input gains/income accurately.

•Review the current investment restrictions for qualifying (distributor) funds.

•Review the rule that all funds within an umbrella fund structure must satisfy the qualifying conditions before the fund itself can obtain qualifying status. As it stands, an investor in a sub-fund that may itself qualify may be disadvantaged by the non-qualifying status of other funds under the umbrella.

There is also the important point that if a fund manager wishes to promote qualifying distributor funds in the UK and the often preferred accumulating structures in continental Europe, two fund ranges have to be offered, thus increasing the costs.

The Government appears to be ready to consider the possibility that particular funds within an umbrella structure could qualify and others not.

It is perhaps most worrying that, in section 5.3.15 of the consultation document, the Inland Revenue stresses the need to “compensate” for the tax loss that would occur if tax on investment income could be avoided by investment in overseas roll-up funds. It is not clear what it means by “avoided” since, under the current regime, tax is only deferred and the rolled-up gain is charged to income tax when the gain is realised.

A clue is perhaps given in the next sentence, which states: “But we are concerned that the ability to defer liability – and the flexibility that deferral gives taxpayers, courtesy perhaps of their residence or domicile status – may offset any disadvantages that still remain in paying income tax on the disposal of units or shares in a non-qualifying fund.”

This focus on the possibly unacceptable benefit of tax deferment is one that is of concern perhaps even for the providers of offshore bonds – structures which also give rise to legitimate tax deferment opportunities.

The Inland Revenue also touts the idea of having investors calculate their share of taxable income from the fund on an accruals basis but recognises the compliance burden involved here.

Of course, this was exactly the point addressed in the personal bond issue, where the outcome was specific anti-avoidance legislation incorporating provisions for the assessment of a deemed or hypothetical chargeable event gain on the investor on a year-by-year basis if the bond was “offensive” under the terms of the new rules.

Even in its summary, the Inland Revenue states that it sees difficulties in the “deferral of tax liabilities” and puts forward the possibility of extending the scope for the taxation of non-qualifying funds on a mark-to-market basis, much like UK life funds do with their unit trust holdings.

The big difference with non-qualifying funds is that they would be outside the jurisdiction, so there would presumably be a need to hypothecate amounts on an accruals basis to investors based on the determined mark-to-market basis.

Another option is to replace the current system completely with new legislation. Here, the proposal for discussion is to introduce a new regime treating UK and offshore funds on a similar basis. The key would seem to be for offshore funds wanting to market in the UK and avoid any year-on-year accruals charge to provide vouched information to the UK authorities.

Compliance would have to be voluntary but would, in effect, be a condition of avoiding a harsher tax regime. Such funds would be known as information-providing funds.

Similar issues arise to those considered previously by the EU on the matter of interest earned by offshore accounts. The choice for dealing with this was to tax interest on an arising basis or to go for information sharing on such accounts between the relevant tax authorities. Subject to temporary relaxation for Austria, Belgium and Luxemburg, the EU chose information sharing.

This issue has arisen recently in respect of the Channel Islands and their recent agreement to comply with this principle. I will look at some of the issues that could emerge from information sharing next week.

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